(Repeats column first published Monday with no changes to text)
By Jamie McGeever
ORLANDO, Fla., Jan 17 (Reuters) - The dollar's slump,
despite a raft of positive news that should be the springboard
for a strong start to the year, is puzzling. But puzzled or not,
hedge funds are sticking to their guns, betting that the
greenback will soon bounce back.
Pulling back the lens a little, the dollar was on the skids
before the turn of the year. It has now weakened four weeks in a
row for the first time since July 2020 and only the second time
in three years.
In a mirror image of last year, when it defied the
overwhelming consensus that it would weaken, the dollar is going
against the current consensus that is should strengthen.
Hedge funds, at least, seem to be holding their nerve. The
latest Commodity Futures Trading Commission data for the week
ending Jan. 11 show that speculators held a net long dollar
position against a wide range of major and emerging market
currencies worth almost $20 billion.
That is little changed over the past six weeks. Indeed, as
the following chart shows, funds' conviction over the past three
months that the dollar will strengthen has been strong and
steady.
Its continued decline in the face of a dramatic ratcheting
up of U.S. interest rate expectations, with Fed officials right
across the 'dove-hawk' spectrum now advocating tighter policy,
is particularly surprising.
Money markets are pricing in almost 100 basis points of rate
increases this year starting in March, and most big banks on
Wall Street have revised their outlooks along these lines. JP
Morgan Chief Executive Jamie Dimon thinks there could even be
six or seven hikes this year.
U.S. bond yields have surged, and CFTC funds have opened up
their biggest net short 10-year Treasury position in two years.
The sell-off at the short end has pushed the two-year U.S. and
German yield spread out to over 150 basis points, the widest gap
in favor of the dollar in the pandemic era.
As analysts at Bank of America note, the last few weeks
could not have been more dollar-friendly: U.S. inflation at a
40-year high of 7%, consistently hawkish Fed-speak pointing to a
March liftoff and 'quantitative tightening' this year, U.S.
rates selling off, and equities correcting lower.
CREDIBILITY - 'TOP OF THE PILE'
But the dollar is not playing ball.
It just had its biggest weekly fall against the yen (-1.2%)
since November 2020 and sterling is on its strongest weekly run
since May. Against a basket of major currencies, the dollar is
down 0.8% this year.
What gives? Perhaps the market is looking beyond the Fed's
rate hike path for signs that other central banks will soon
start tightening policy.
Until last week, even the suggestion that the European
Central Bank could start raising rates this year was fanciful.
But more than 10 basis points of tightening is now being priced
in, and even the Bank of Japan is debating how soon it can start
telegraphing an eventual interest rate hike.
"As long as interest rate differentials do not move
materially much further in the dollar's favor, it will become
difficult for the dollar to extend its rally, now that yields
outside the US are also progressively moving up, both in Germany
and in Japan," wrote Unicredit's FX team on Friday.
For the dollar to turn around quickly, as hedge funds and
most analysts expect, the Fed may have to send an even more
aggressive signal from its Jan. 25-26 policy meeting.
The dollar often strengthens ahead of the start of a Fed
tightening cycle then eases off once it gets underway. While the
Fed won't change policy later this month, it will likely clear
the runway for liftoff in March, and give further detail on when
and how it will start reducing its balance sheet.
Having steered the market to lean toward four rate hikes and
'quantitative tightening' this year, the onus may be on the Fed
to back up rhetoric with action.
As former Fed Vice Chair Alan Blinder commented last week on
Fed communication more broadly: "Generating trust and
credibility is absolutely critical, top of the pile for central
banks. You do that by doing what you said you will do."
(By Jamie McGeever)